Homework 1 Forwards and Futures

(Due Nov 4th, 5 pm)

FNCE 6008 Derivatives Analysis
Professor Jianfeng Hu
1. A trader enters into a one-year short forward contract to sell an asset for $100 when the
spot price is $90. The spot price in one-year proves to be $95.
(a) What is the traders gain or loss from the forward on the maturity date? Draw the
gain/loss diagram for the trader.
(b) What is the gain or loss of the buyer of this forward on the maturity date? Draw the
gain/loss diagram for the buyer.
2. (a) What the are the main shortcomings of the forward contracts?
(b) How are futures contracts designed to overcome these shortcomings?
3. Consider a coffee futures contract (37,500 lbs per contract). The December contract was
settled at $1.1675 per lb on 2nd September. Suppose we bought 1 December futures on
2nd September (day 0). On the 4 succeeding trading days, the December contract settled
at the following prices:$1.1043, $1.1523, $1.2004, and $1.1650. Compute:
(a) The gains and losses in these 4 days.
(b) If the initial margin was $5,000 and the maintenance margin was $4,000 for each
contract, compute the dollar value of the margin account after 4 days, assuming you
earn no interest in the account.
4. Mark-to-Market Reduces Credit Risk: Edwin buys 10 gold futures at $1,400/oz with maturity in 250 days (contract size 100 oz). Suppose the gold futures price goes down $0.2
every day for 250 days.
(a) How much will Edwin pay at maturity without marking-to-market?
(b) How much will Edwin pay daily with marking-to-market?
5. Calculate the fair forward price on a non-dividend paying stock whose current price is $50,
assuming 5% interest rate and one year to maturity. How can you make an arbitrage profit
(i.e., 0 net investment and positive, risk-free return) if
(a) The actual forward price is $53.50?
(b) The actual forward price is $51.61?

6. Compute the fair forward price under the same assumptions as in the previous question
except that the stock will pay a dividend of $2 five months from the date the forward
contract is negotiated. How can you make an arbitrage profit if
(a) The actual forward price FA is $51.41?
(b) The actual forward price is $49.53?
7. Compute the fair forward price for a one year forward contract under the same assumptions
as in Question 5 except that the stock is expected to provide a continuous dividend yield
of 2% per year. How can you make an arbitrage profit if
(a) (a) The actual forward price is $52.60?
(b) The actual forward price is $50.05?
8. Take the formulas for a forward (or futures, for our purposes) contract. What will happen
to the forward price around the ex-dividend day, if the underlying asset (say, a stock) was
to pay a dividend? Will the share price change, if the dividend was announced well before?
Why or why not?
9. Suppose the annual interest rate is 5% with continuous compounding. The IBM stock is
trading at $185. What is the fair forward price of a forward contract which calls for delivery
of 1 share of IBM stock at the end of one year? Construct arbitrage portfolios and analyze
cash flows to show that this is indeed the fair forward price.
10. Suppose you bought a six-month forward contract on a non-dividend paying stock on June
1. The interest rate is 5%, the stock price on June 1 was $25. Suppose today is September
1 and the stock price is $35 now. What is the value of his position?
11. As a copper tube manufacture in Singapore, you will need 50,000 lbs copper in December.
The current futures price is $0.7090 per lb. The copper futures contract size is 25,000 lbs.
(a) How would you hedge?
(b) If the December spot price is $0.7100, what is the net cost of the hedged copper?
What if the December spot price is $0.6900?
(c) Is the net cost with hedge always less than that without hedge?
12. A wholesaler will purchase 1.5 million gallons of gasoline on November 1 in the spot market
and would like to hedge on September 1. He hedges with crude oil futures (the contract size
is 1,000 bbl). He uses historical data to compute S = $0.0505 per gallon, F = $1.6/bbl,
and = 0.95. How many contracts should he buy or sell?
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13. Suppose that S&P 500 index value is currently at 1,605.00. The continuously compounded
rate of interest rate is 5% per year. The dividend yield is estimated at 2.25% per year.
Whats the futures price for a futures contract that matures in three months?
14. Suppose on July 23, the DJIA index was at 14,650, the September futures was at 14,700,
the December one was at 14,800, and the maturity dates were 56 and 154 days away,
respectively. The risk-free rate is 5.10% (Assume there are 360 days per year).
(a) What would be the fair futures price if we assumed the dividend on the DJIA was
zero between July 23 and the time the December futures matures?
(b) What is the present value of the future dividends that is embedded in the market price
of each futures contract? Ignore transaction costs in your calculations.
15. As a portfolio manager, you have a portfolio worth $2,000,000 and decide to hedge a possible
market downturn risk with the S&P 500 futures for 4 months (the multiplier of the contract
is 250). Suppose S&P 500 index is 1,500.00, the interest rate is 6%, the dividend yield on
index is 4% and the portfolio = 1.5. How many futures contracts should the manager
trade? Buy or Sell?
16. Suppose that on September 1, a UK firm agreed to buy 2 Boeing 747 from Boeing on
December 1 at a price of $90m each. The September 1 spot exchange rate was $1.6730/.
The December futures was quoted at $1.6612/.
(a) What was the exchange rate risk that this UK firm faced?
(b) Should it long or short the futures in to hedge this risk? How many futures contracts
(the size of contract is 62,500)? Explain why this position serves as a hedge.
(c) Compute the total costs to the firm when the Dec. 1 spot exchange rate is $1.6550/ and
when the Dec. 1 spot exchange rate is $1.6705/. In which case, the total costs are
lower without hedging?